What Is the Primary Mechanism That Causes Impermanent Loss in an Automated Market Maker (AMM)?

The primary mechanism is the divergence in the price ratio of the two assets from the time of deposit. AMMs use a mathematical formula, like x y=k, to maintain a fixed product of the token quantities.

When the external market price changes, the pool's internal price becomes misaligned. Arbitrage traders exploit this difference by buying the cheaper asset from the pool or selling the more expensive one to the pool.

This rebalancing process is what causes the loss relative to simply holding the assets.